Alasdair Macleod explains how “preference for money” impacts price levels and what role a shift in preferences will play in a ‘virtually certain’ new banking crisis.
“We are all aware, through application of logic if nothing else, that if you increase the quantity of money, prices will increase as that extra money is spent. What is less appreciated is that prices can change dramatically due to shifts in preference for money over goods.”
“An illustration of this was the fall in prices during the financial crisis five years ago, when over-extended consumers responded to the global banking crisis. Government interventions in capital goods markets, such as for residential property and automobiles, were urgently implemented to stop prices collapsing. Shifts in money-preference can be very dramatic, as that episode showed.”
“Despite the massive expansion of money-quantities in the major economies, prices for goods have been generally stable, though government CPI statistics tend to be self-serving rather than reliable price inflation indicators. Instead of fuelling price increases, money has instead been applied to reducing indebtedness, or to speculation in the capital markets.”
“What is important to understand is five years ago there was a large one-off shift in favour of money, which suggests that the next large shift will be away from money;“
“So where will a reduced preference for money come from? … When the bullish factors for government bonds and other financial assets are replaced by the prospect of rising interest rates and falling prices, there will be a rush for the exit across a wide range of markets.”
“It is a virtual certainty that collapsing bond and other asset prices will set off a new crisis by undermining the collateral backing the entire banking system. Central banks will see no alternative to keeping interest rates as low as possible, accelerating the expansion of the money-quantity to prevent a new systemic crisis.“
“Cash will therefore be an unattractive alternative to owning financial assets, which leaves vital commodities and monetary hedges, such as precious metals, as the only refuge for monetary capital.”
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